Southwest Airlines 1994 Annual Report Download - page 28

Notes to Consolidated Financial Statements
Southwest Airlines – 1994 Annual Report Page 28
Prior to 1993, Morris was treated as an S-Corporation for federal and state income tax purposes under
applicable provisions of the Internal Revenue Code and various state tax laws. Therefore, no provision for
income taxes was made prior to 1993. Morris made regular cash distributions to its shareholders sufficient
to meet their tax liabilities. Upon termination of S-Corporation status on December 31, 1992, the
undistributed S-Corporation retained earnings were reclassified to capital in excess of par value.
Additionally, Morris established $3,032,000 of deferred income taxes for the cumulative differences in the
timing of reporting certain items for financial statement and income tax purposes. These deferred taxes
related primarily to depreciation. The establishment of deferred taxes was offset by a reduction of capital
in excess of par value.
Merger expenses of $10,803,000 relating to the merger of Southwest and Morris have been included in
1993 operating expenses as required for financial reporting purposes; however, these expenses have been
separately reported as “ merger expenses” to reflect the impact of the nonrecurring expenses on operating
results. Included in these one-time costs resulting from the merger were $1,900,000 of various
professional fees; $4,703,000 for disposal of duplicate or incompatible property and equipment; and
$4,200,000 for Employee relocation and severance costs related to elimination of duplicate or
incompatible operations. During 1994, the integration of Morris into Southwest was substantially
completed, including the disposal of incompatible property and equipment and settlement of Employee
relocation and severance costs.
3. Accounting Changes
Income Taxes Effective January 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109, “ Accounting for Income Taxes” (SFAS 109). As a result of adopting SFAS 109, the
Company recorded deferred tax assets of $6,977,000 and reduced deferred tax liabilities by $9,048,000 at
January 1, 1993, which resulted in an increase to the Company's 1993 net income of $16,025,000 ($.11
per share) for the cumulative effect of the accounting change.
POSTRETIREMENT BENEFITS Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 106, “ Employers' Accounting for Postretirement Benefits Other Than
Pensions” (SFAS 106). The cumulative effect of this change in accounting method at January 1, 1993
reduced 1993 net income by $766,000 (net of benefit from income taxes of $469,000) or $.01 per share.
The effect of adopting SFAS 106 on 1993 income before cumulative effect of accounting changes was not
material.
SCHEDULED AIRFRAME Overhauls Prior to January 1, 1992, the Company expensed scheduled airframe
overhaul costs as incurred. This practice was adopted at a time when costs were relatively constant from
year to year and consistent with the growth of the fleet.
Given the significant growth of the Company's fleet and the Company's 1991 modification of its airframe
overhaul maintenance program with the Federal Aviation Administration (FAA), Southwest changed its
method of accounting for scheduled airframe overhauls costs from the direct expense method to that of
capitalizing and amortizing the costs over the periods benefited. The Company believes this method is
preferable because it results in charges to expense that are consistent with the growth in the fleet;
improves financial reporting; and better matches revenues and expenses.
For the year ended December 31, 1992, the Company recognized approximately $6,900,000 in
amortization of airframe overhaul expense. Had the direct expense method been used to provide for
scheduled airframe overhaul costs during the year ended December 31, 1992, income before cumulative
effect of accounting change would have been reduced by approximately $9,800,000 (net of provision for
income taxes and profitsharing of approximately $8,800,000), or approximately $.07 per share.